Financial Development and Regulatory Reform in China

HUANG Ying China Institutes of Contemporary International Relations

Joint workshop on Financial Evolution, Regulatory Reform and Cooperation

IDEAs – SNU Center for Social Sciences – SNU Political Economy and Social Policy RC

17-18 May, 2013

Structural shifts in financial sector

• Commercial banks

• Non-bank financial institutions

• Shadow banking sector

• Capital markets

• Local government debts

By the end of March 2013, the commercial banks expanded their assets to 141.3 trillion RMB,

equivalent to 270% of its GDP.

0

50

100

150

assetsdebts

The top ten profit-making banks in the world in 2011

rank bank Profits（ billion dollars）

1 Industrial and Commercial Bank of China

43.2

2 Construction Bank of China 34.8

3 Bank of China 26.8

4 JP Morgan Chase & Co 26.7

5 Agricultural Bank of China 25.1

6 Wells Fargo 23.3

7 HSBC 21.9

8 Mitsubishi UFJ Financial Group 17.6

9 Citibank 14.6

10 BNP Paribas 12.5

Expansion of non-bank financial institutions by the end of 2010

Financial institutions

Total assets (trillion RMB)

Change from 2006 (%)

Securities company

2.24 530

Fund management company

2.51 332

Insurance company

4.9 120

bank 92 116

Mushrooming of the non-financial institutions

Non-financial institutions with financial functions by the end of 2011,

• 4,282 small-scale loan companies

• 5,237 pawn companies

• 8,402 financing guarantee companies

Rise of Alternative Financing

Local government debts by the end of 2010 (roughly 25 percent of

GDP)

Shifts in Financial Structure

Expansion of M2 in China (trillion RMB)

High risks in the rapid expansion of the banking sector

• (1) Property price bubble

• (2) Local government debts

• How healthy is banking sector in China?

• How to reform it to create a more equitable competitive and resilient banking sector?

Commercial Banks’ Performances in 2011

bank Capital adequacy ratio (%)

Non-performance loan ratio (%)

Net profits (billion yuan)

Industrial Commercial Bank of China

13.2 0.94 208

Agricultural Bank of China

11.9 1.55 122

Bank of China 12.9 1.00 130

Construction Bank of China

13.7 1.09 169

Bank of Communications 12.4 0.86 51

All commercial banks 12.7 0.96 1040

Financial reform

• Narrow sense: • interest rate reform

• private capital’s entry into financial sectors• capital market development• more open to foreign investments

• Broad sense• exchange rate formation mechanism reform

• capital account opening• internationalization of RMB

Interest rate reform

• Why reform:• (1) the negative deposit rates help foster the

shadow banking sector, which is a destabilizing factor (various trust products; questionable wealth management products; interaction between the banks and non-bank entities).

• (2) the big gap between deposit and loan rates raised the question why the banks are allowed to make money so easily.

• (3) believed to make the banks more competitive in the markets and more responsibility for their own choices.

Interest rate reform

• Liberalizing the interest rates mainly means increasing the lending rates and reducing the deposit rates.

• In June 2012, PBC announced that commercial banks will be allowed to set the interest rates charged on their loans at or above 80 percent of the government’s benchmark rate, down from the previous 90 percent. The central bank also gave them permission to set deposit rates at or less than 1.1 times the government benchmark rates.

• Later, PBC further lowered the lending rates from 80 percent of the benchmark rates to 70 percent.

Three financial reform pilot zones

(1) Wenzhou: transparency of private lending.

(2) Zhujiang Delta: for internationalization of its financial services.

(3) Quanzhou: to better service the real economy.

Measures to develop capital markets

Future reforms as identified by the China Financial Stability Report 2012:

(1) Expand the direct finance.(2) Encourage a multi-layered capital market system, to

diversify Banking system’s risks(3) Actively promote the securitization of credit assets

guided by the principles of simplicity, transparency and reasonable share of risk costs.

(4) Encourage the commercial banks to set up fund management companies in an orderly way, to support the healthy development of capital markets.

Exchange rate formation mechanism reform

Reasons for pursue this reform

(1) conform to the international mainstream practice under the great external pressures (especially from US).

(2) Believed that a more resilient exchange rate system can dampen the speculative attacks on its currency, Which is against the experiences of many floating exchange-rate countries.

China’s Current Account Surplus

Capital account opening• Capital account opening has always been

connected with the need to internationalize RMB. However, the link between the two is questionable.

• Historical experiences by Britain and America were clearly different.

• Japan’s efforts were fruitless.• EU has never actively pursued it.• For China, to promote the use of RMB is

necessary, but opening the capital account may not be helpful.

Financial regulation system and reform

• China’s financial regulation system is modeled on America’s.

• China’s financial supervision system consists of “one bank and three commissions”. One bank refers to the Central Banks, and the three commissions are Banking Supervisory Commission, Securities Supervisory Commission and Insurance Supervisory Commission.

• As China moves to universal bank system, this supervision system will be less effective.

Some observations:

• Chinese government’s mind is occupied by the needs to liberalize the financial sector for various reasons, not to revamp its regulatory system.

• China successfully withstood the two big financial crises, not because it had sound financial system.

• China also thinks that the western banking practices, including the new BASEL rules are more advanced than its own. It’s still in the phase of “learn and adapt”.